Is Weakness In Devon Energy Corporation (NYSE:DVN) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?

With its stock down 16% over the past three months, it is easy to disregard Devon Energy (NYSE:DVN). However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Specifically, we decided to study Devon Energy's ROE in this article.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for Devon Energy

How To Calculate Return On Equity?

ROE can be calculated by using the formula:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Devon Energy is:

53% = US$6.0b ÷ US$11b (Based on the trailing twelve months to December 2022).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.53 in profit.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

Devon Energy's Earnings Growth And 53% ROE

Firstly, we acknowledge that Devon Energy has a significantly high ROE. Second, a comparison with the average ROE reported by the industry of 30% also doesn't go unnoticed by us. Under the circumstances, Devon Energy's considerable five year net income growth of 54% was to be expected.

As a next step, we compared Devon Energy's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 18%.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. Is DVN fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Devon Energy Efficiently Re-investing Its Profits?

The three-year median payout ratio for Devon Energy is 46%, which is moderately low. The company is retaining the remaining 54%. By the looks of it, the dividend is well covered and Devon Energy is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Moreover, Devon Energy is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 31% over the next three years. Regardless, the future ROE for Devon Energy is predicted to decline to 25% despite the anticipated decrease in the payout ratio. We reckon that there could probably be other factors that could be driving the forseen decline in the company's ROE.

Summary

On the whole, we feel that Devon Energy's performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. Having said that, on studying current analyst estimates, we were concerned to see that while the company has grown its earnings in the past, analysts expect its earnings to shrink in the future. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

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